Eurozone Leaders Agree on Some Rescue Details

When failure is too painful to contemplate, any halting motion in something resembling the right direction will be hailed as success.

Eurozone leaders had a session well into the night and announced a sketchy deal that dealt with one major stumbling block, which was getting a deep enough “voluntary” haircut on Greek debt. Government officials regarded it as key that any debt restructuring be voluntary, since no one wanted to trigger payouts on credit default swaps written on Greek debt (a default or forced restructuring would be deemed a credit event and allow CDS holders to cash in their insurance policies, and that could trigger a bigger rout). The banks were unwilling to accept the 60% haircut sought by the Eurocrats, but agreed to a 50% reduction.

The only other seemingly new developments were a commitment by the ECB to “maintain” its bond buying program and confirmation that the various bailouts would be funded by the gimmick of leveraging the EFSF to a much larger size.The Financial Times said that Merkel and Sarkozy said the amount could not be calculated now, but analysts estimated that it would be bigger than €1 trillion, while Bloomberg reported €1.4 trillion. Banks are also required to increase their capital levels to 9% or face the prospect of unpleasant government-assisted recapitalization.

Although the details of the deal as outlined by both European leaders and the Institute of International Finance remained vague, officials said that €30bn of the €130bn in the government bail-out money would go to so-called “sweeteners” for a future bond-swap, which would be completed by January.

Some €35bn in such “credit enhancements” were included in the original July deal with the IIF, an association of global financial institutions. In that deal, the money was used to back new triple-A bonds that would be traded in for debtholders’ current bonds.

Whether the new programme would be organised in a similar fashion remained unclear. Such factors as the interest rates and maturities for new bonds are critical to determining how valuable the swap will be for private investors

Charles Dallara, the IIF managing director…said …his consortium would need to continue to work with authorities “to develop a concrete voluntary agreement”….

Some elements of the package appeared to be based on optimistic assumptions.

Consider what this means: the part of the bargain that was the focus of the negotiating effort, the haircut on a voluntary Greek restructuring, has been agreed upon only at a high concept level. Remember that the earlier deal, a 21% haircut, was supposed to get a 90% participation rate, then the officials decided they could live with 80%, but the uptake rate came in at roughly 75%. Will the IIF do a better job of delivering its members this time? There was some bizarre face saving bluster in the official presentation. The officialdom had clearly wanted a 60% haircut, so beating them back to 50%, with details to be sorted out (which if the US is any guide, will work to the advantage of the financiers). So notice the posturing, per Bloomberg:

Sarkozy said the bankers were escorted in “not to negotiate, but to inform them on decisions taken by the 17 and then they themselves went on to think and work on it.” Luxembourg Prime Minister Jean-Claude Juncker said the banks’ resistance was broken by a threat “to move toward a scenario of total insolvency of Greece, which would have cost states a lot of money and which would have ruined the banks.”

I doubt that anyone with an operating brain cell thinks the Eurozone leaders were willing to break the banks. And the overall scheme, in particular the €1 trillion+ rescue facility, as we have discussed in prior posts, is unworkable unless real money comes in. That either means the ECB, which the Germans are dead set against, the IMF, which will contribute but not on a scale to be sufficient, or China. Bloomberg said that Sarkozy was going to call Chineser president Hu Jintao to hit him up for funding tomorrow.

Even though this plan, such as it is, has lots of gaps, including an insufficiently large rescue facility (Sarkozy’s brother Olivier, head of the financial services group at Carlyle, in an FT op ed earlier this week, estimated the total required for banks alone to be $2 trillion, or €1.4 trillion, and that’s before you add in sovereign rescue requirements).

Mr. Market is nevertheless cheered by this sketchy, flawed outline. Most Asian markets were up over 2%, the Dax is over 3% higher, the FTSE has nearly 2% in gains, and the euro is close to 1.40. Perhaps the Eurocrats can keep these “get us through the next crunch” rescue packages going, but each deal seems to be harder to push over the line.